November 2016 - End of the Road?

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40 | TH E M R EP O RT O R I G I NAT I O N S E R V I C I N G A NA LY T I C S S E C O N DA R Y M A R K E T ORIGINATION THE LATEST Fed Wants the Largest Banks to Hold Even More Capital Gov. Tarullo announces new capital buffer and stress test exemption process for smaller firms. F ederal Reserve Gover- nors Daniel Tarullo and Jerome Powell warned the industry in separate public addresses back in June that the Fed may soon require the nation's largest bank holding companies to hold significantly more capital as part of its an - nual stress testing. In a recent speech at Yale University titled "Next Steps in the Evolution of Stress Testing," Tarullo said the nation's central bank has proposed reforms to the Comprehensive Capital Analysis and Review (CCAR), which is the Fed's annual test to evaluate the largest bank holding companies' capital planning processes and capital adequacy in order to protect the country's financial system from economic shocks similar to the 2008 crisis. Those reforms include a higher capital buffer requirement for the eight largest institutions (ranked by assets), and an exemption from the CCAR for some smaller bank holding companies. The eight bank holding companies affected by the new capital requirements are Bank of America, Citigroup, Goldman Sachs Group, Inc., JPMorgan Chase, Morgan Stanley, Wells Fargo & Co., State Street Corp., and Bank of New York Mellon Corp. Tarullo referred to these firms as global systemically important banks, or GSIBs. Tarullo told the audience at Yale that "in pulling this package of modifications together, we have consciously shaped them in accordance with the principle that financial regulation should be progressively more stringent for firms of greater importance, and thus potential risk, to the financial system." Some smaller firms will no longer be subjected to the Fed's stress testing, according to the new proposal. Tarullo announced that there will be an exemption from the CCAR for firms with less than $250 billion in assets that do not have significant international or nonbank activity. Approximately 25 regional banks will be affected by this change. "As noted earlier, many of these firms have already met supervisory expectations," Tarullo said. "We do not intend for less complex firms to invest in stress testing capabilities on par with the most complex firms and, given their profile, we feel these firms can maintain the progress they have made through the normal supervisory process, supplemented with targeted horizontal reviews of discrete aspects of capital planning." Tarullo said the Fed will provide more information on the new capital plan next year, and that the changes will not affect the stress tests in 2017, which will likely be conducted sometime during the summer. Capital requirements for the banks have already been significantly raised since the financial crisis in 2008, which has forced the banks to evaluate whether or not they can maintain their current size and still be profitable. JPMorgan Chase, which is the largest bank in the country by assets, has already shrunk in response to the Fed raising capital requirements during normal times in 2015, according to the Wall Street Journal. History is Not Repeating Itself with FHA Loan Risk Index shows FHA loan risk is down 17.7 percent year-over-year. F ederal Housing Adminis- tration (FHA) mortgage loans have historically been riskier than con- ventional mortgage loans because borrowers on FHA loans typi- cally have lower credit scores and high LTV ratios on their loans. The surprising recent data shows, however, that FHA loans may not be as risky as they have been historically—and in fact, lately, have been less risky than conventional loans. The First American Financial Corp. Loan Application Defect Index for August 2016 revealed that conventional loan risk is down 14.6 year-over-year, com - pared to a 17.7 percent decline for FHA/Veterans Affairs (VA)/U.S. Department of Agriculture (USDA) transactions for that same period. Also, the transac - tions involving FHA/VA/USDA loans were found to be 14.5 per- cent less risky than conventional mortgage loans. The Loan Defect Index is down by nearly a third (31.4 percent) since peaking in October 2013. The loan application and defect risk on transactions involv - ing FHA/VA/USDA loans has declined more in recent years than that of conventional mort- gage loans, according to First American. "While FHA loans continue to have higher credit risk relative to conventional loans, the big improvement in application and defect fraud risk is likely due the significant cost risk associated with non-compliance and defec - tive mortgage documents that is unique to FHA loans," First American Chief Economist Mark Fleming said. Not only is the risk down for FHA/VA/USDA loans down compared with conventional mortgage loans, but the volume is up. The recently-released American Enterprise Institute/ First American National Mortgage Market Index (NMMI) showed an increase of 9.2 percent in Q2 2016, compared with last year, and that the share of FHA- backed mortgage loans has increased relative to the volume of conventional loans. "[We] have observed an increase in the share of FHA loans in the market," Fleming said. "While the share of FHA/ VA/USDA loans is up, the loan application defect risk on them is down. This has had a positive impact on overall defect risk in the market and partly explains the large decline in defect risk we have seen in the past year." The Defect Index for refinance transactions, and for purchase transactions both declined substantially over the year, by 18.1 percent, and by 10.2 percent, respectively. For refi transactions, the Purchase Index has declined at a faster rate (41 percent) than for purchase transactions (24 percent) since both peaked in late 2013.

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